60 Seconds with… Giovanni Cespa, Professor of Finance, CASS Business School

As an independent observer, what are your thoughts on the Plato Partnership project and their aims more generally?

I am a member of the CEPR, and first heard about the Plato Partnership when together with Imperial College London, it organised its inaugural academic conference in London, last June.

Technological innovation has influenced in a profound way the activity of financial markets over the past twenty years. The dramatic decrease in information processing costs, aided by regulatory intervention, has led an industry that once abided by the monolithic paradigm of the “natural monopoly” to morph into a much more competitive and diverse one. Nowadays, financial instruments contemporaneously trade on different platforms where the rules governing transparency and the market information end-users can access, differ widely.

Such a seismic transformation, has raised a broad range of issues that deserve further investigation. For instance, do we have a clear understanding of how transparency affects market quality and/or the welfare of different market participants? The answer to this type of question is likely to benefit from the interaction between market participants, who see the market from the end-user perspective—with more of a positive angle, and academics who, instead, tend to have more of a normative view. In this respect, the Plato Partnership has the potential to deliver rigorous research that better addresses practical problems.

What role do you think academia can play in the development of global market structure?

Academics can bring rigorous reasoning and modelling techniques that can help articulate the debate in a systematic way, contributing to market development and the Plato Partnership project.

Let me give a couple of examples. Recent microstructure research sees the availability of liquidity as an important measure of market quality, and an objective that exchanges need to pursue, a view that is also shared by regulators and market users. However, liquidity ultimately captures the compensation that intermediaries receive to make the market work, and—abstracting from frictionless market paradigms—it is hard to imagine a real market that is infinitely liquidity.

This begs the question of what is the level of liquidity a market can “reasonably” achieve, and what does such a level depend on. The answer to this question is somewhat complicated, though. For example, for given market structure, a likely, important liquidity “driver” is the willingness of market participants to get involved in trading (How much capital can they commit to this activity? How tolerant are they to the risk that such an activity implies? How risky is their position in the market?). Yet, market structure is by far not given, and, especially in the present environment where financial innovation is ripe, is likely to change, for example as a result of technological innovation. Thus, an additional factor that is likely to impinge on market liquidity is the structure of the exchange industry. This raises a host of new questions that touch upon the industrial organisation of the market. For example, how does competition among exchanges/platforms affect liquidity provision? Is unbridled competition desirable? Alternatively, is it possible that it is somewhat conducive to a suboptimal outcome that damages market participants, for instance because of the likely duplication of investment that entry may imply? Ultimately, an answer to this question can come from the analysis of models that encompass the welfare of “all” market participants: traders, liquidity providers, and exchanges.

In these frameworks, payoffs are well defined so that one can measure how beneficial liquidity provision is for traders, how rewarding it is for the intermediaries who facilitate the trading process, and how profitable it is for the platforms that allow its provision. Furthermore, this type of research can facilitate the role of regulatory intervention.

Another area where debate on market structure is thriving and academics can contribute, is the role of computerised trading. A first batch of empirical results in the literature has suggested that that the advent of computerised intermediation has had a positive impact on liquidity provision. However, a number of “incidents,” the most infamous of which is represented by the May 2010 “Flash-Crash”, have led regulators to question such a benign view.

This has raised a number of important questions. First, can we really single out computerised trading as the culprit of these events? Next, if this is the case, is there a trade-off between market stability, on the one hand, and liquidity, on the other. If so, to what extent can higher liquidity be considered a priority in an environment where sudden liquidity dry ups can, and do occur? This type of questions is again likely to benefit from the interaction between academics and market participants, something that the Plato Partnership has the potential to facilitate.